Time-and-Materials vs Fixed Price: which payment model to choose for product development?
May 1, 2023
When outsourcing product development, two of the most popular pricing models are used: Time-and-Materials and Fixed Price. Both have their advantages and disadvantages, but neither is a perfect solution. Even within one company or one development area. Let's talk about why this is the case and what we've done to create a better outsourced development experience for the customer.
A Fixed Price contract assumes a full understanding of the final cost of the project. The price is made up of the following:
The scope of work. Both the entire scope of work and the scope of individual steps, if these are anticipated, shall be captured.
The content of the work. Both participants understand how many and what tasks are to be completed as part of the project.
The timing of the work. Time estimates include the exact number of working hours of a project to achieve an intermediate or overall result.
The model is most often used when there are clear requirements and set deadlines, a limited budget or an MVP is requested. Usually, development adjustments are governed by a new contract.
In the T&M model, the contractor is billed for the actual amount of work based on the hourly rates agreed with the client. The team's timesheet records all of the team members' time spent on tasks.
T&M is used for long-term projects and lack detailed requirements for the product as well as for flexible work direction and speed.
Fixed Price advantages
The company understands the budget and clear deadlines and thus can plan its financial strategy with certainty.
If both sides agree on everything, no surprises are expected.
Simplicity of management
Because of the results and deadlines approved at the beginning, the workflow requires minimal involvement and control by the client.
Fixed Price disadvantages
If a work plan has been drawn up, a team is already in place and the hours of work have been allocated, it takes time to drastically change the direction of development or to swap tasks. And it often happens that it is vital to deal with things that are not in the contract.
Doubts about quality
To avoid penalties, companies are keen to deliver the project on time and in the full scope. Sometimes it is done against the quality of the project.
Once our team had worked on a mobile app for an industrial sector’s working client. The project had an agreed roadmap for the next 6 months, agreed tasks, deadlines and budget. Two months after the start of the project, the client's project manager informed us that the holding company had purchased several more factories abroad, in the United Arab Emirates. Consequently, the customer needed to ensure that the application would work in the new factories. At the same time, the total budget was agreed upon and it was very difficult (almost impossible) for us to go beyond it. Therefore, we had to hold many additional meetings, seeking a compromise between simplifying the implementation of previously planned functions or partially abandoning them, and prioritizing what was vital to do right now. Yes, we stayed within budget, but it was a challenging month-long period. However, it was an internal customer product. Open market products are characterized by an even greater degree of uncertainty and influence from external factors.
Roman Martirosyan, Loovatech CEO
Advantages of Time-and-Materials
Contracts with T&M allow the company to change the scope of work, direction, speed or prioritize tasks at any time depending on the context.
Working without detailed initial requirements
In development, it may be that the objective is clear, but it is more effective to develop an implementation strategy and precise requirements in the process.
Speed of project start-up
With T&M, work starts immediately, without long pre-project analysis, clarification of all the details of the future product and multiple steps of agreeing specifications with the customer.
Disadvantages of Time-and-Materials
Because the customers pay for the time the team works, not for a specific result by a specific deadline, sooner or later they have a question about the effectiveness of the work. Plus, without certain competences in development, it is very difficult for the customer to understand the project in detail and have a well-founded opinion of it.
If you look at all customer objections to Time And material, the top question will be "How do I know that they are not intentionally spending more time on development? Personally, more than once I've heard the questions "How can I verify that the team is working accurately?", "Can I trust the time-spent reports?", "What interest does the team have in allowing fewer bugs if I am essentially paying them separate money to fix them?" Thus, the Time-and-Materials model only works if there is a high level of trust between the customer and the team.
Vasily Kolosov, Loovatech CTO
What if both systems have disadvantages?
Our experience shows that with open market products, the Fixed Price model loses all its advantages and greatly hinders project development.
For startups, the T&M model is more suitable. But in order to trust the development team, the customer must have access to the program code, project documentation and all the other artifacts of the project, including the handling of tasks. He must see everything that happens to his project, so that even without strong technical competences to understand the details.
It is the radical increase in clarity of the development process that will alleviate the disadvantage of the T&M model and ensure trust in the development team.
In addition, the customer's constant access to all project artifacts can have an impact on work efficiency. This creates a certain amount of pressure on the contractor, which motivates the team to perform better.
For our customers, we have developed an app that allows the customer to look inside the development process and see their project live.